Procter & Gamble Stock Is Out Over Its Skis As Investors Got Defensive

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PG stock - Procter & Gamble Stock Is Out Over Its Skis As Investors Got Defensive

Source: Mike Mozart via Flickr (Modified)

Defense is the new offense. Or so investors have come to believe in recent months as markets tumbled on concerns about slowing economic growth. While market growth darlings like Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), and Nvidia (NASDAQ:NVDA) have been knocked down since October, defensive names like McDonald’s (NYSE:MCD), Coca-Cola (NYSE:KO), and Procter & Gamble (NYSE:PG) have soared to all-time highs.

However, this rush has inflated defensive stock valuations to levels that aren’t sustainable. In particular, I’m worried about one headline name in that group that looks due for a pullback: PG stock. The shares have gained more than 29% since the beginning of May, compared to the S&P 500 index‘s 2.4% decline.

The growth narrative supporting PG shares is steadily improving. Organic growth rates are healthy, particularly in the consumer giant’s more-profitable U.S. segment, so margins are heading higher. That healthy sales growth and the margin expansion are powering strong earnings growth. Moreover, this is one company that’s largely resilient to a recession given its portfolio of consumer staples.

Still, the rush to defensive stocks over the past few months has inflated the valuation on PG stock to levels that both don’t make sense and are historically unsustainable. This bubble will last only so long as investors remain unsure about a recession. But if a recession hits, PG stock will go down. Or, if recessions concerns cool, PG stock will go down, too.

As such, it is only a matter of time before this stock drops from currently over-inflated levels.

Valuation Is Overextended

The biggest problem with PG stock is that its current valuation is simply way too big.

PG stock sports a 22x forward multiple that is more at home among tech stocks. In the group of Facebook, Nvidia, Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOGL), and Activision (NASDAQ:ATVI), PG’s 22x is right in the middle of the forward P/E multiple range from 18x to 25x for those stocks. That doesn’t make much sense. All of those companies have secular growth tailwinds in rapidly growing digital, data, and AI-related markets. PG sells beauty and household products in a largely saturated market.

Meanwhile, PG’s 22x forward multiple is above the stock’s five-year average number that’s below 20. In fact, over the past five years, PG stock has traded at a similar 22x forward earnings only twice. Once was in late 2014, just ahead of the stock’s 20% decline in 2015. The other time was in late 2017, right before the stock fell more than 20% in early 2018.

The same is true if you look at the dividend yield. The current yield on PG stock is below 3%, versus a five-year average yield of 3.2%. The yield was also below 3% in late 2014 and late 2017, again, preceding 20%-plus corrections in PG stock.

Overall, the valuation on PG stock today is simply too big to be sustainable in a long-term window. History says a big correction in PG stock is due soon.

Uncertainty Won’t Last Forever

The fundamentals also support a thesis that PG stock is out over its skis at current levels.

The reason the shares have rallied to all-time high valuation levels is that rush into defensive names due to broad economic uncertainty. The uncertainty won’t last forever. Either we enter a recession in 2019, or we don’t.

If we don’t, then PG stock will fall because investors will stop playing defense. Let’s assume broad economic and earnings growth is pedestrian but healthy in 2019. That will lead to a market rally, marked by a switch away from defensive names and back to growth plays. In that scenario, investors sell PG stock and it drops.

If we do enter a recession, then the shares will fall because, while resilient to economic weakness, PG stock isn’t recession proof. Consumer demand, even for consumer staples, gets hit during recessions. And, the company has a ton of debt which would get pressured. After all, during the 2008 recession, PG stock fell about 40%.

Overall, the current uncertainty that’s inflating PG stock won’t last forever. Eventually, it will be replaced by a hard answer. When that happens, regardless of the answer, PG stock will likely drop.

Bottom Line on PG Stock

Procter & Gamble is a good company and a solid long-term investment, just not here, and not now. The current valuation is over-inflated, and it will inevitably deflate over the next several quarters. As it does, PG stock will fall.

As of this writing, Luke Lango was long FB, AMZN, NVDA, MSFT, GOOG, and ATVI.


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/proctor-gamble-stock-is-out-over-its-skis-as-investors-got-defensive/.

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